Understanding the Advantages and Disadvantages of Invoice Factoring

Reviewed:1st February 2016

Factoring your invoices is an efficient and reliable way to raise regular amounts of working capital. It removes the stress and pressure of paying bills on time, and allows you to plan ahead for sustainable growth.

Factoring advantages and disadvantages vary according to your type of business, but the main overall change that you’ll notice is regular cash advances from your lender. Amounts are based on the invoices you send out – usually between 80% and 90% of each approved invoice.

Advantages of invoice factoring

Planning for growth

Many small businesses still find it difficult to attain ‘traditional’ bank lending, but the characteristics of invoice factoring make it less risky, not just for the bank, but also for the borrower.

Business expansion becomes possible on a number of different levels:

Increased marketing budget

Capacity to purchase additional capital assets

Confidence that liabilities will be met

Hiring of extra staff to meet demand

If your business is ready, invoice factoring can be one of the safest ways to fund growth without risking an existing positive cash flow situation.

More time to focus on the business

Invoice factoring involves handing over control of your credit procedures to the lender. This offers several benefits, not least of which is the extra time you have to run the company.

Focussing on the ‘bigger picture’ rather than dealing with the minutiae of daily operations is motivating in itself, and can bring about positive change across the business. The task of chasing payments is in the hands of your lender, and you can focus your efforts where they’re needed most:

Providing enhanced customer service

Working on tasks that generate sales

Strategic planning

No limit on available borrowing

The limit to your borrowing is tied only to the number of approved invoices sent out, so you aren’t dependant on long credit checking procedures and onerous paperwork to obtain additional funding when you need it.

Fast access to cash

Generally, cash is advanced within 24 hours of an invoice being sent. This fast access enables you to operate the business cost-effectively, and when compared with the usual 30 or 60 day time-lag between invoice despatch and receipt of monies, you can see how greater flexibility is offered in terms of your own payments:

Early payment discounts may become available from your suppliers, which in some cases cover your lender’s fees

There’s no doubt that staff salaries and other regular bills will be paid during the month

Long-term liabilities are covered

Factoring negates the need for other types of funding

Leveraging the value within your sales ledger means that capital assets remain untouched. Although other forms of asset-based lending are useful, invoice finance is flexible, and allows access to finance without the risk of excessive debt.

Low risk for both parties

Invoice factoring is low-risk for both parties. You won’t need to provide any personal guarantees or collateral, and because lending is based on work already completed, the lender’s risk is reduced. The factoring company is also in charge of collecting payments, and it’s likely that they will have robust, efficient procedures in place.

With so many advantages and benefits to factoring, it would be easy to overlook potential negatives. But as with any type of lending, invoice finance might not be right for all businesses.

Disadvantages of factoring

Complex exit process

It can be difficult to exit a factoring agreement due to the sudden drop in levels of cash coming in. This would need to be well-managed, but it’s not an insurmountable problem. Additionally, some lenders require a long period of notice to terminate an agreement.

Fees, costs and other terms

It’s important to understand the terms you might be offered within a factoring agreement, and have an idea as to what your business needs. If fees and charges seem high, it’s important to take account of the possibility for long-term growth rather than looking at the short-term situation.

Customer service

If good customer relationships are a feature of your business, factoring your invoices could damage your image as a company. Customers may take exception to placing their debt in the hands of a third party.

Operational changes

Some agreements result in changes to the way in which a business is run. This may be the case if one or two of your customers are not sufficiently credit-worthy, or that you’re not maximising opportunities within the market.

On balance, the advantages of factoring appear to outweigh the disadvantages, but much depends on how efficient your sales ledger processes are, as well as your level of turnover.

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Real Business Rescue is a trading name of Begbies Traynor (Central) LLP a limited liability partnership registered in England and Wales No. OC306540. The firm is authorised by the FCA to undertake debt counselling and debt adjusting and its reference number is 660455. Copyright 2018 Real Business Rescue, all rights reserved.